Making Bankers Wait...

The banks have created a bonus system that encourages economy-destabilizing investment bubbles. That seems foolish. So here's a proposal: a tax cut to encourage bonus reform.
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I could really use $700,000, though I understand that no one is all that eager to give it to me. Of course, I don't work for Goldman Sachs, where the average employee is on track to earn roughly that much this year. If you are anything like, well, anybody who doesn't work at Goldman Sachs, you might find this sum a trifle preposterous. You might even think that a bank that received at least $10 billion dollars from taxpayers earning an average annual income of $31,632 (as of 2005) might be more hesitant to drown their employees in this much wealth. Simply from a PR standpoint it seems really really stupid. But then, you do not work in the financial world where pretty much everyone considers wealth on this magnitude a god-given right.

President Obama assured us yesterday afternoon that, "We will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses."

Good on us and let's hope that's true. But many are skeptical about the chances for major banking reform and what with the Republican party ready to stand stalwart against pretty much anything that the president might suggest, I stand among them. So let me propose something on a much more modest scale.

As the President pointed out, this last crises was born -- at least in part -- from bonus incentives that encouraged bankers to make short term gains at the expense of long term viability. While the rules governing bonuses varied according the bank and the branch an employee worked in, the general notion was (and is) that bankers earned a bonus according to the added value they brought in to the bank.

To oversimplify: if I earn Goldman Sachs $1 billion, I get a $10 million dollar bonus. Forget, for the duration of this article, any objections you might have about the justice of anyone earning more than 19 times as much as the average American, much less the notion that someone trading electronic representations of goods and services makes dramatically more than any of the people who produce those goods and services. Also: ignore any objections you might have to the social utility of bankers versus any of the hundreds of millions of people who are paid less.

Ignoring all that, these bonuses seem like a good idea from the bank's perspective. Quite honestly, if someone made me $1 billion, I would be willing to give them 1% of that as well as a nice Christmas card to show my appreciation.

But even forgetting the above-mentioned objections, there are two really big problems with these bonuses: the first is that they come without any accompanying liability. If I bet $100,000 of my own money on a start-up company and that company fails, I lose my $100,000. If someone at Goldman bets $100,000,000 dollars of Goldman's money (or, more accurately, Goldman's investors' money) on a real-estate instrument that goes bad, he doesn't get his bonus. He might even lose his job. But it's the investors who lose the $100,000,000.

The second problem is that these bonuses are paid out annually. So if I, hypothetically an investment banker here, make a series of bets on sub-prime real estate instruments in 2006 and they pay off heavily in 2006, then I get a huge bonus in 2006 that's mine to keep. I don't lose that money even if the investments I made go to pot in 2007 and then continue declining into 2008 and then the federal government buys them so that my bad investments don't drag the entire economy into a depression in the fall of 2008. Sure I might get laid off, but I still have the money I made in my 2006 bonus regardless of how poorly that bonus reflects the actual value of my investments.

Basically, the banks have created a bonus system that encourages economy-destabilizing investment bubbles. That seems foolish. So here's a proposal that even the most laissez faire free-marketeers ought to be able to rally behind: a tax cut. Not just any tax cut of course. This would be a tax cut to encourage bonus reform.

While laying out the full parameters of this notion in twelve hundred words isn't really feasible, here is the basic idea:

Investment banks, hedge funds, and other organizations that pay their employees and managers with bonus-based schemes would be able to opt into a 'bonus savings account' that would reach viability in ten years' time. This account would have to consist entirely of liquid assets and it would be reserved for whoever was receiving the bonuses. The account would track investments an employee at a bank made over a ten-year term. So the investments I make for my employer in 2009 will result in a bonus paid out to me in 2019. If my investments lose money, the bank has the right to withdraw money from this account. So my hypothetical investments in the housing bubble of 2006 produce no bonus for me, since they didn't pay out over a long term.

Why would any righteously greedy banker take one of these accounts rather than demanding the current bonus schemes stay put? Here's where the tax cut comes in: anyone opting into one of these bonus accounts would receive, say, a 10% reduction in their marginal tax rate. Furthermore, the bonus would grow with their investments. If I invested in Google in 1999, my 2009 bonus would reflect the growth in the value of that investment. Moreover, by creating a publicly searchable database that would let consumers know which firms are using these bonus accounts, investors could tell which firms are so confident in their long-term performance that they are willing to abandon short term bonuses. The vast majority of invested money comes from huge public funds whose primary interest is long-term growth. These firms would almost certainly choose to disproportionally invest with banks whose employees were willing to take deferred bonuses.

There's a reasonable chance that these tax cuts would pay for themselves by increasing long-term economic stability and growth. In case you're worried though, why not offset the cuts with a marginal tax increase on those who receive their bonuses annually? What, after all, could be more fiscally conservative (and thus theoretically palatable to the bloodthirsty Republican opposition) than rewarding long-term savings?

You might object that bankers today make their money by making daily trades in their portfolios. Look, you might say, modern banking is based on hundreds of complicated instruments and only investment bankers like Warren Buffet still stick with the outdated model of making the kind of slow long-term trades that would be trackable under this system. 'Exactly,' I might say.

But even forgetting snide comments like that one: computing power is so inexpensive that tracking the value of terribly complex trades is becoming more and more feasible. I am neither a programmer nor a mathematician, but I am confident that there are people out there who could design and program a system to track the value of individual bankers over ten years. And what with the stabilizing effects that this system might have on the economy, those people could well be worth, say, $700,000 a year.

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